LIZ: Get in While You Can

We still think that most people won’t really be interested in LIZ until it’s a $10 stock. The opacity of the model is lifting, and the value is there. Get in while you can.



One of the knocks on LIZ, and reasons for its underperformance, has been strategic inaction at the management and board level – those days are gone. In addition to posting positive top-line trends and its first revenue growth in 5-years back when sales were twice what they are today, LIZ provided much welcomed clarity around some of its recent strategic initiatives. With the addition of greater visibility, as well as positive fundamental improvement across each of its brands, the catalysts are in place to drive shares substantially higher over the immediate-term TRADE (3-weeks or less) and intermediate-term TREND (3-months or more).


Management acknowledged that it does indeed have “several irons in the fire”, confirming a recent article that it’s shopping its MEXX business. The senior leadership team is also pursuing other potential asset sales with the intention to de-lever and substantially ‘de-risk’ the company by year end. While a sale is one of the near-term catalysts, a deal can only be considered speculation until it’s made public. So let’s focus on the facts:


1)      The company added both sizing and timing around its actions to reduce Mexx’s underperforming store base and regardless of a potential sale, it’s much bigger than expected. The plan is to close 1/3 of Mexx stores (all in Europe) by the end of the first half of FY12 with 70 by the end of January and another 35-40 by the end of the first half of next year. This could amount to a $60mm reduction in operating losses according to our math (see below).


2)      Another incremental change in the quarter was an additional $25mm in cost savings expected in FY12 from the sale of the last company-owned DC facility. Combined, we expect these steps to reduce SG&A margin by at least 500bps next year in addition to increasing confidence in the company’s ability to achieve EBITDA of $200-$220mm in 2012.


3)      For the first time in over 3-years, every direct brand comped positively with Juicy, Lucky and Mexx all comping significantly better than expected. Perhaps most noteworthy, were the results out of Mexx with comps coming in at +3.6% and fall wholesale orders up 11%. The results reflect continued momentum in the turnaround of the company’s biggest variable business - which is now under way (accounting for roughly 1/3 of total revs and generating $90mm in operating losses each of the last two years).  We’re the first to admit that when something comps down for long enough, it’s eventually going to hit rock bottom. But this is positive for LIZ nonetheless.


Juicy was probably the next biggest surprise with comps coming in flat, but is still expected to comp down slightly in 2H with the new product coming through later than expected. A significant reduction in inventories (down 9%) impacted margins in the quarter, but will be key to driving improved profitability in 2H. At Lucky, a rebound in the women’s business and strong denim sales, which account for ~60% of revenues, accelerated the top-line. Kate Spade, to put it simply, is crushing it. We expect continued strength in these two brands throughout the back half.  


4)      Due to Q2 results and incremental cost savings initiatives underway, the company reaffirmed its prior 2011 and 2012 outlook. The only change was in the confidence with which management spoke to Mexx’s profitability, shifting from a ‘hope/goal’ of EBITDA breakeven to stating that it would be breakeven “at a minimum” by 2012. In addition, it was suggested that Mexx could in fact post a positive operating profit next year (ironic statement just as it prepares for a sale), which is what we have modeled given the changes underway. Regardless of the company’s wordsmithing of what it hopes, prays, or expects EBITDA to be  – we are still confidently modeling $235mm.


5)      It’s impossible to ignore leverage, given our sense that it is the #1, 2 and 3 most relevant factors for investors when analyzing LIZ.  In fact, debt increased this quarter to $769mm up from $716mm in Q1 due to the increase in Eurobond debt as a result of the foreign currency exchange as well as CapEx and restructuring. While we expect debt to increase further in Q3 due to higher working capital requirements, we should see a substantial reduction by year-end. In fact, the company expects debt at year-end to be below 2010 year-end levels ($578mm). In an effort to mitigate this overhang, the company is clearly looking to sell an asset (or two) that would accelerate de-levering the company and be a materially positive catalyst for shares.  It is important to remember that this is not a capital intensive business, it is a working capital intensive business. When LIZ jettison’s Mexx, the removal of working capital drag will be disproportionately large relative to the parent company.


Bottom-line, with greater visibility and improving fundamental performance, we expect multiple expansion and greater interest in the name to drive shares higher from current levels. Shares are currently trading at 5.8x our 2012 EV/EBITDA estimates. Assuming a 6.5-7x multiple suggests 25% to 40% upside from here and an $8 to $9.50 stock.

We recognize that stocks don’t trade on sum-of-parts…but the reality is that the opacity of this model has been so intense for the past four years that most investors literally haven’t known what they’ve been buying. Now that the core Liz brand is stable and growing, the sourcing office is shuttered, retail stores are closed, Mexx is on the block, and DC is on its way out the door, people will see what they’re getting to a much greater extent.


We have included our current 2011 SOTP (which takes into account current debt of $768mm) as well as what 2012 could look like assuming $500mm in debt and modest multiple expansion across key brands. Keep in mind that the DKNY license rolls off at year-end in 2012 (it’s operating at a slight loss) and Mexx will most likely no longer be in the portfolio accounting for ~$1.50 in value from this analysis. That still leaves you with over $15 in value and significant upside from here. As bullish as we have been recently on LIZ, we are incrementally more bullish on the near to intermediate term outlook for the company.



Mexx Store Consolidation Analysis:


Here’s our Mexx store consolidation analysis and the impact it could have on the company and Mexx business. At Mexx Europe you’re looking at close to a 60/40 retail/wholesale split. Based on the assumption that 70 stores close by year end and another 35-40 in 1H 2012 with stores up to 10-12k sq. ft. (we used a 9k avg.) at an average sales productivity of $200 per sq. ft., we are looking at a $190mm hit to revenue on a base of ~$315mm. With consolidated Mexx sales productivity of ~$250 per sq. ft. (including Canadian retail), we discounted these stores at 80% of an underperforming European store base. The key takeaway here is the removal of ~$60mm in operating losses associated with these stores.


LIZ: Get in While You Can - mexx store closures

LIZ: Get in While You Can - LIZ SIGMA

LIZ: Get in While You Can - 1 yr comp projectory

LIZ: Get in While You Can - 2 yr comp trajectory

LIZ: Get in While You Can - brand rankings


Casey Flavin


Texas Roadhouse reports after the market close.  Price action in the name has been soft lately as casual dining has underperformed other categories within Food, Beverage and Restaurant sectors.


Our fundamental view of Texas Roadhouse is currently negative from a top-line perspective.  While there has been an improvement in average check from an increase in price, the comp remains traffic-heavy.  Traffic compares are increasingly difficult over the next three quarters.  Given that TXRH’s customer is sensitive to elevated gas prices, it is possible that high gas prices, while declining through 2Q from an early May peak, could have impaired the company’s top-line.  In terms of any commentary around 3Q, July saw gas prices gain 4.4% to $3.70 on a national average basis.  The stock is currently trading at 7.5x EV/EBITDA NTM versus 8.3x when we penned our casual dining top-line snapshot on 7/20.  Still, it remains the fourth most expensive stock in the casual dining space (behind BJRI, DIN, and BWLD) and we think there are better plays on the long side within the category, such as EAT at 6.5x.


The macro environment is certainly raising some red flags at the moment.  Various economic data points, as well as 2Q earnings in general, have come in below expectations.  We will be listening keenly to see if management alters its forward-looking statements.


Hedgeye’s quantitative setup for TXRH is bearish, as the chart below illustrates.





Below is a selection of forward-looking statements from the most recent earnings call and our take on each.



SALES TRENDS:  “First quarter comps increased 4.6%, and the first four weeks of the second quarter have started off very strong as well, with comps up 5.4%. Increased traffic has been the main driver and we believe that's a result of continued market share gains. In addition, the pricing we took in March is flowing through which is very encouraging…we are also experiencing improvement in check, as our average check is running up a little over 1% after the increase we took back in March. Based on what we're seeing in terms of sales, we're comfortable assuming 3.5% to 5% comparable sales growth for the year, and combining this with operating week growth of a little north of 5% gets us close to 10% revenue growth for the year.”


HEDGEYE: TXRH saw strong sales performance during the first four weeks of the second quarter and, given the continuing strong numbers from Malcolm Knapp’s Knapp Track casual dining sales figures, we would expect that the strong sales performances continued for the remainder of 2Q.  Management’s assertion that the price increase in March flowed through well in April is positive, but as the chart below illustrates, the concept has typically relied on traffic for top-line growth.  Any shift in consumer behavior in the face of higher check prices could impair traffic growth in the face of tougher year-over-year compares going forward.





GAS PRICES:  “that's where we're closely monitoring it [gasoline prices].  I think there's some delayed reaction to this stuff and we need to be very, very careful.”


HEDGEYE: On the margin, gas prices were less of a headwind during the balance of 2Q than at the time when management held the most recent earnings call (May 2nd).  However, we will be watching for commentary about the ensuing bounce in gas prices through July and the concurrent softening of economic data.



NEW UNIT PERFORMANCE:  “In addition to our comparable store sales continuing to grow, sales performance at our newer restaurants continues to outperform our existing restaurant sales. This plus the cost reductions we saw in overall development costs last year further validates our decision to build more restaurants this year and in 2012.”


HEDGEYE: The Company is planning to grow aggressively in 2012 and we believe that changes on the margin in commentary on new unit performance are important to watch. 



COMMODITY COSTS: "We now expect commodity inflation to be higher than we had originally anticipated and believe that it is prudent to slightly revise our EPS expectations for the year.


For the quarter, commodity inflation was approximately 3%. Although we have seen some easing on some specific produce items, we are certainly anticipating these costs to be higher for the year than we originally forecasted.  This is the driver behind us increasing our expectations for commodity inflation in 2011 from approximately 3% to approximately 4%, and thus we are revising our diluted EPS expectations as well."


HEDGEYE: Commodity costs remain elevated for TXRH, and we expect the company to highlight the drought in Texas and other events as reason for caution regarding their commodity basket. 



EARNINGS EXPECTATIONS: "Margins remain our biggest challenge. We are anticipating that restaurant margins will be down this year, although it's too early to predict how much. This is primarily due to the commodity inflation as I've mentioned. Netting the potential for better than originally anticipated comparable sales with higher commodity costs led us to moderate our estimated EPS growth for 2011 from approximately 10% to 5% to 10%...I’ll tell you to get to the upper end of our EPS guidance we’d be hard pressed to get to the 10% side of that without any additional pricing within that 3.5% to 5% traffic."


HEDGEYE: TXRH would not be alone this earnings season if it were to miss lofty expectations.  Given consumer confidence trends, the fact that gas prices remain elevated, the employment situation remaining dire and economic data softening quite substantially, we would think it quite risky for a traffic-reliant concept like TXRH to raise prices further in 2H11.



GROWTH:  We are absolutely on track in accelerating our development plans for this year and for 2012…We are growing faster and our pipeline is larger as we are preparing to grow even more restaurants in 2012…While this results in higher pre-opening costs, we understand that the key to creating long-term shareholder value is to invest capital and assets earning a higher rate of return than what that money costs. That is good for our shareholders and very good for our teams, as growth creates opportunities, energy and excitement.


HEDGEYE: There is a long lead time for TXRH to indentify a site and progress through the preopening process but it will be interesting to see if management remains as bullish on growth today as it was in May and if new unit performance is holding up in the recent months.



Howard Penney

Managing Director


Rory Green


Weekly Latin America Risk Monitor

Weekly Latin America Risk Monitor




Latin American equity markets were fairly mixed, with the two markets we’ve been most bearish on YTD leading the way to the downside from a wk/wk perspective (Brazil’s Bovespa Index down -2.4%; Chile’s Stock Market Select down -4.4%). In the FX market, the Colombian peso declined sharply (down -1.3% wk/wk) on dovish commentary from Finance Minister Juan Carlos Echeverry. In the fixed income market, Brazil’s 2yr sovereign yields shot up +13bps wk/wk on renewed inflation concerns. We’ll be out with a deep dive on Brazil later in the week.


Weekly Latin America Risk Monitor - 1


Weekly Latin America Risk Monitor - 2


Weekly Latin America Risk Monitor - 3


Weekly Latin America Risk Monitor - 4


Weekly Latin America Risk Monitor - 5




Brazil: The key callouts out of Brazil last week continued to center on inflation. From near-term perspective, the FGV IGP-M inflation index (60% wholesale; 30% consumer; 10% construction) slowed for the second consecutive month in July (-0.12% MoM), marking the second consecutive monthly decline – the first back-to-back MoM declines since July/August of 2009. We continue to see Brazilian CPI peaking in August, but remaining substantially elevated relative to the central bank, the government, and the sell-side’s expectations over the long-term TAIL. Elsewhere, Brazilian officials introduced yet another policy measure designed to slow real appreciation – this time a 25% tax on derivatives transactions. As we’ve seen in the credit market, the government’s efforts to weaken its currency and cool the economy haven’t quite had the desired effect. Rather, they’ve simply boosted government’s tax revenues for a country which the World Economic Forum already ranks dead last from a burden of taxation perspective.


Colombia: Finance Minister Juan Carlos Echeverry hit the tape with some very dovish comments regarding the future scope for interest rate policy as well as Colombia’s foreign exchange rate and the market took his word for it (COP/USD down -1.3% wk/wk; 2yr sovereign debt yields down -11bps wk/wk). We would expect to continue to see additional strength in the IGBC General Index as the combination of accelerating growth, peaking inflation, and dovish policy (on the margin) support further bids for Colombian equities (up +1.6% wk/wk). 


Chile: Chile becomes the latest victim of the slowdown in global manufacturing output and sentiment, with industrial production growth slowing sequentially in June to +4% YoY (more than cut in half from +9.7% YoY prior). On the flip side, Chilean retail sales growth accelerated to +12.5% YoY in June, supporting consulting firm A.T. Kearney recent decision to jump Chile three spaces up on its 2011 Global Retail Development Index to third (behind Brazil and Uruguay). Though we continue to like countries with sound fiscal policy like Chile over the long term (last week, the government affirmed its commitment to reduce its deficit to 1% of GDP vs. 3% currently), we remain bearish on the intermediate-term TREND of Chilean economic growth. Down -10.2% YTD, Chile’s Stock Market Select Index is surely pricing this in.


Darius Dale


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European Risk Monitor: Pause in the Storm?

Positions in Europe: EUR-USD (FXE); Italy (EWI); UK (EWU); European Financials (EUFN)

On the day following the July 21st announcement of Greece’s second bailout package risk across the European periphery (PIIGS) nose dived according to sovereign bond yields and cds spreads (see charts below). Yet in the days since both metrics have resumed higher and flirted with key breakout levels (6% on 10YR yields and 300bps on sovereign CDS), all of which gives us pause to monitor the developments of this long term sovereign debt soap opera. Currently we’re short the EUR-USD via the etf FXE; and short Italy (EWI), the UK (EWU), and the European Financials (EUFN) in the Hedgeye Portfolio to take advantage of the headwinds we see over the immediate and intermediate terms.


European Risk Monitor: Pause in the Storm? - 1. yields


  • Please note that CDS may not be the best indicator of risk because the International Swaps and Derivatives Association (ISDA), which governs CDS pricing, has ruled that the Greek restructuring does not constitute a credit event, which means that CDS will not be triggered. 

European Risk Monitor: Pause in the Storm? - 2. cds


Here are a few points to considering regarding the EFSF as we move forward in the calendar:

  • While it’s true that the bonds issued from the EFSF are AAA rated, proposed at very favorable rates of 3.5% to borrowers, and the fiscally sober-minded Germans are posting the largest amount of collateral to back the facility, it’s apparent that at its current level of €750 Billion (€250 Billion of which is IMF contribution) the facility could not handled the default of Italy and Spain, two country that we think present significant risk in the larger puzzle of the region’s fiscal imbalances. Estimates already suggest the facility would need to be expanded 2-4x to meet the needs of Italy and Spain.
  • The new structure of the existing EFSF needs to be unanimously voted on by all EU member states, which includes the individual terms of lending (maturity extension and interest rates commanded) as well as the total size of the facility. If the original issuance of the EFSF (being used for Ireland and Portugal) and the permanent ESM facility (beg. 2013) are any indicators of sentiment, we could well see indecision on the terms, especially on its overall size as individual countries (populaces) would rather not be on the hook for the peripheral countries debt. This vote isn’t scheduled until mid September when the EU parliament returns from summer recess.
  • To this point, last week we heard from German Finance Minister Schaeuble who said the EFSF will not be given carte blanche to buy up bonds on the secondary market. This is a critical point for there’s been no indication that yields for the PIIGS are compressing. As a nod to higher yields, Italy sold €2.7 billion of 10-year government bonds late last week at an average yield of 5.77% vs 4.94% on June 28. The ECB (along with China) have unofficially/officially been critical buyers of sovereign issuance ytd. Should the EFSF be limited in any capacity to buy up sovereign issuance this could encourage yields higher (neg.) and/or require other funding solutions.
  • As we’ve highlighted in our research, Italy and Spain face significant bonds coming due into year-end and in 2012. This means that the country will have to rely even more on successful future bond auctions (ie sufficient demand at yields not significantly over previous auctions) to fund its costs = more downside risk.  Specifically, we continue to see political risk in Spain, both into and out of Prime Minister Zapatero’s announcement on Friday for early elections on November 20th. On the same day Moody’s warned that it may downgrade Spain.

European Risk Monitor: Pause in the Storm? - 3. piigs

  • Finally, there’s also the unknown on how the voluntary bank swaps of Greek debt will go off. 90% of banks say they’ll participate, but there’s plenty of uncertainty around this. It's scheduled for late Aug/early Sept.


Growth Slowing

On the road to 40? European Manufacturing PMI figures for the month of July came in today and the numbers confirm a downward trend over the last 3-4 months. With the 50 line marking expansion (above the line) and contraction (below), Europe’s stalwarts were not immune to the trend: Germany fell to 52.0 and France declined to 50.5. July showed that four of the countries that reported measured below 50 (UK, Spain, Ireland, and Russia), with nine of the twelve countries reporting falling month-over-month, two expanding (Italy and Poland), and one flat (Turkey). In the case of Italy, July’s reading just got it over the 50 hump.  With sticky stagflation in the UK, today’s data point gives us more conviction in our short EWU position. Suffice it to say, these PMI numbers don’t look good!


European Risk Monitor: Pause in the Storm? - 4. m pmi


Levels on EUR-USD

As Keith mentioned this morning, the EUR/USD is the one strike price that should continue to whip around in the next 48 hours as we finally put the US debt ceiling debate to bed; watch $1.43 as your intermediate term TREND line that inflates/deflates everything else (across asset classes). The global market’s correlation risk moves off that. Our immediate term TRADE levels are $1.42 - $1.44.


European Financials CDS Monitor 

Bank swaps in Europe were mostly wider last week.  36 of the 38 swaps were wider and 2 tightened, with Italian and Spanish spreads leading the charge higher. 


European Risk Monitor: Pause in the Storm? - 5. banks


Matthew Hedrick



Keith shorted DNKN this morning in the Hedgeye Virtual Portfolio.


Paying a higher multiple for DNKN than SBUX does not make sense to us.  We published our Black Book one week ago outlining our longer term fundamental view of the stock and our view that the coffee space is currently in a bubble.  Valuations have sky-rocketed over the past year.  As we have written and communicated to clients ad nauseam over the past week, DNKN is a domestic regional brand with a plan to grow domestically into new markets within the U.S.  We find the practicalities of that plan less-than-certain and would absolutely not support a higher valuation for DNKN versus SBUX which has more convincing growth prospects via international markets, K-Cups, and other brands like Tazo Tea.  Additionally, given the fact that broader economic growth in the U.S. is and will likely continue to be below that of international markets where Starbucks is focusing its growth, we are only further convinced that the DNKN-SBUX premium is unsustainable.  We continue to see the advertisement, below, posted on industry websites; the company needs to provide "special incentives" in select markets to attract franchisees.  If the story is that good, why the incentives?


DNKN: TRADE UPDATE - SHORTING - dnkn incentives


For a copy of our Black Book on DNKN, please email


In terms of catalysts, the company is reporting 2Q earnings on Wednesday, August the 8th before the market open.   The first question to focus on is whether or not the company can deliver on exceedingly high expectations.  Dunkin’ Donuts has had mediocre top-line growth over the past couple of years and, we believe, investors need to take quite a leap of faith, by our reckoning, to pay the multiple the stock price is currently demanding for the as yet uncertain growth plans.   



Howard Penney

Managing Director


Rory Green



Macau blew the doors out in the last week of July. 



Average daily revenue increased 19% from the prior week and was 9% above the average for the first half of the month.  In total, gross gaming revenue grew 48% YoY to HK$23.5 billion, above our estimate of HK$22.5-23.0 billion.  At this point, we don’t know how much of a factor hold played but we surmise that it was high given the huge surge in revenues the past week.


In terms of market share, MPEL and Wynn were again the standouts with market share of both equal to their pre-Galaxy Macau opening levels.  LVS and MGM continued to lag in July which we think were both related to volumes and hold.  Galaxy Macau appears to have reached its stride, jumping to 19.1% from 17.7% post the opening of its flagship property.  Similar to Q2, we think MPEL should have the most upside relative to current EBITDA expectations for Q3.



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